Altman Z-Score
The Altman Z-score combines five balance-sheet and income ratios into one number that estimates a company's risk of bankruptcy. Below about 1.8 signals distress, above 3 a safe zone, and the range in between a grey area.
Before a company fails, its finances usually show warning signs: thin working capital, little retained profit, weak earnings and heavy debt. Edward Altman turned those signs into a single score in 1968, and it is still one of the best-known tools for spotting financial distress. This entry explains the formula, the zones and its limits.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Z-score, Altman's Z-score, Z-score bankruptcy model
- Updated
The Z-score in plain words
Altman's Z-score uses several balance-sheet values and income to predict the likelihood of financial distress.1
A score below 1.8 suggests distress and a high chance of bankruptcy; 3 or above suggests a safe zone; between them is a grey area.1
Its creator, NYU Stern professor Edward Altman, is an internationally known expert on corporate bankruptcy and credit risk.2
How the Z-score is calculated, step by step
Working capital ÷ total assets
× 1.2 — short-term liquidity.
Retained earnings ÷ total assets
× 1.4 — accumulated profit.
EBIT ÷ total assets
× 3.3 — operating profitability.
Market value of equity ÷ total liabilities
× 0.6 — cushion against debt.
Sales ÷ total assets
× 1.0 — asset efficiency.
Add them up
Compare with the distress and safe zones.
Worked examples
Example 1 — A healthy company
Safe zoneRatios: WC/TA 0.20, RE/TA 0.30, EBIT/TA 0.15, MVE/TL 1.50, Sales/TA 1.10.
| Weighted terms | 0.24 + 0.42 + 0.495 + 0.90 + 1.10 |
| Z-score | ≈ 3.16 |
A score of 3 or more places a company in the safe zone.1
Example 2 — A distressed company
Distress zoneRatios: WC/TA −0.05, RE/TA −0.10, EBIT/TA 0.02, MVE/TL 0.30, Sales/TA 0.80.
| Weighted terms | −0.06 − 0.14 + 0.066 + 0.18 + 0.80 |
| Z-score | ≈ 0.85 |
A score below 1.8 points to financial distress and a high bankruptcy risk.1
Example 3 — Grey area
Grey areaA company scores 2.4.
| Zone | Between 1.8 and 3 |
Scores in the grey area suggest a moderate chance of bankruptcy and call for closer analysis.1
Z-score zones
| Aspect | Score | Meaning |
|---|---|---|
| Distress | Below 1.8 | High bankruptcy risk |
| Grey | 1.8 to 3 | Moderate risk |
| Safe | 3 and above | Low risk |
| Applies to | Original model | Public manufacturers |
How the Z-score is used
Screening stocks
Avoiding companies at risk. See Zombie Companies.
Credit analysis
Judging borrower risk. See Credit Rating.
Short ideas
Spotting deteriorating balance sheets. See Short Selling.
Monitoring holdings
Tracking financial health over time.
Advantages and disadvantages
Advantages
- Combines several risk signals into one number.
- Uses public financial statements.
- Long, well-studied track record.
Disadvantages
- Built for manufacturers; less suited to banks or tech.
- Uses backward-looking accounting data.
- Can be distorted by accounting choices.
Going deeper
Read as far as you need. Each level builds on the one before it.
Data source
Beginner
The model relies on information in a company's annual 10-K report.1 See SEC Filings: 10-K, 10-Q and 8-K.
Other versions
Intermediate
In 1983 Altman developed versions for private manufacturers and non-public companies with different weightings.1
Investor use
Advanced
Investors may consider selling stocks whose scores approach 1.8, given the higher probability of bankruptcy.1 Combine it with cash-flow analysis. See Free Cash Flow.
Common mistakes
Using it on banks
Financial firms need different models.
Treating it as certain
It estimates probability.
Ignoring trends
A falling score matters more than one reading.
Using stale data
Update after each report.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The Z-score predicts bankruptcy risk from five ratios.
- Below 1.8: distress; above 3: safe.
- It was created by Edward Altman.
- It suits public manufacturing companies best.
- Use it with other analysis.
Frequently asked questions
How accurate is the Z-score?
Can I use it for tech companies?
Where do I get the inputs?
Further learning
- Interest Coverage Ratio
Another solvency check.
- Debt-to-Equity Ratio
Leverage on the balance sheet.
- Credit Rating
Agencies' view of default risk.
- Bankruptcy
What the score tries to predict.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Altman's Z-Score Model (opens in a new tab) Checked .
- NYU Stern School of Business. Edward I. Altman (faculty biography) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.